Weak economic data fuel fears U.S. recovery has hit ‘soft patch’

The yield on U.S. benchmark debt fell below 3 per cent Wednesday, its lowest level in six months, as weak economic data fanned fears that the U.S. recovery is stalling again.

“It looks like this recovery has hit its second ‘soft patch’ which, for a recovery that is less than two years old, is troubling to say the least,” said Paul Ashworth, chief U.S. economist at Capital Economics.

The latest piece of troubling data was an estimate by ADP, the payroll processor, that the U.S. private sector only created 38,000 new jobs in May — well below a forecast gain of 175,000. Adding to the gloom was a widely followed index of U.S. manufacturing activity, which fell to a 19-month low.

The yield on 10-year notes fell 10 basis points to 2.95 per cent, extending its decline from 3.30 per cent over the past month.

The decline in Treasury yields indicates investors are shrugging off the possibility the U.S. could default as early as August if Congress does not agree to raise the country’s borrowing limit. They are instead paying more attention to evidence of deteriorating growth and a double dip in the housing market before the end of the Federal Reserve’s quantitative easing policy, or QE2, later this month.

Many money managers are underweight U.S. Treasuries in favour of corporate bonds. Some, including Bill Gross at Pimco, have taken a negative view on U.S. Treasuries via futures and swaps, only for the combination of weak data and concerns about contagion from the eurozone debt crisis to boost the appeal of US Treasury debt.

Treasuries generated a return of 1.6 per cent in May according to Barclays Capital, their best monthly performance since August. “The bond bears know there’s plenty of headroom to rally to lower rates if weakening growth fears morph into worries about a double dip,” said William O’Donnell, strategist at RBS Securities.

Traders were reluctant to push Treasury yields well below 3 per cent as they await the May employment report due on Friday. However, some economists lowered their payroll estimates Wednesday and bond traders say slower job growth could drag bond yields even lower, sparking debate about a third round of quantitative easing. “Our forecast that [the 10-year] yield will drop back to 2.5 per cent later this year is on track and we wouldn’t rule out an eventual QE3 entirely either,” Ashworth said.

The Treasury rally was accompanied by weaker equities and a lower dollar. The S&P 500 was down 1.5 per cent, and equities in Europe dropped more than 1 per cent as U.S. growth worries compounded concerns over Greece.